1. Potential red flags – Business environment
Area
Indicators
Macroeconomic
Late stage in the business cycle; economy growing above trend, or in period of anticipated slow growth or decline
Rising and unsustainable leverage at Sovereign/ sub sovereign / financial sector/ corporate/personal level
Political and / or social tension
Changes in the political and /or regulatory environment
Adverse interest and currency trends
Weakening commodity prices
Financial markets
Indications of Asset bubbles
Boom in acquisitions /mergers
Substantial increase in equity issues
growing use of “exotic” financial instruments
markets consolidating following high growth phase
High levels of volatility or “calm before the storm”
Adverse currency and / or interest rate movements
Industry
Changes in the operating environment (regulation; increased competition; technology, collapse in sales prices, environmental legislation etc.)
Either very high growth or mature / declining

2. Potential red flags – market indicators
Area
Indicators
Financial market indicators for a corporate
Equity underperformance relative to peer groups
Stock price not reacting as would be expected to underlying performance
Credit pricing higher than would be indicated by its rating / financial performance
CDS rates and CDS Indices
Loan and bond pricing
Financial leverage and structure that exposes company to relatively small changes in interest and /or currency rates

3. Potential red flags – risks facing the business and management issues
Area
Indicators
Risks
Adverse trends in key drivers of company’s performance (e.g. regulation; major costs; risk concentrations ( e.g. lack of diversification in revenues))
Potentially large operating exposures e.g. lawsuits, operating disasters
Technological developments
Company
High growth rates relative to its peers but declining operating margins particularly if heavily debt financed , and especially at late stages of the economic cycle
Market position deteriorating
Reputation for poor quality products / services
Unusual number of companies in group for its size and many partly owned companies
Significant change in strategy, particularly if there is a large number of leveraged acquisitions in “new” business areas
Lack of flow of information; late and inaccurate information; lack of responsiveness to questions
Corporate
Governance
Control by a limited number of individuals; no external checks
“High profile” or secretive management
Mixed private and public ownership – split capital structure with private owners having control of stock with heavy voting rights

4. Potential red flags – financial performance
Area
Indicators
Accounting
Clear signs of aggressive accounting
Extensive dealings with related companies
Changes in auditors and / or multiple auditors
Small audit firm in relation to size of company
Regular and / or material restatements of financials
Off balance sheet items
and heavy commitments
Major amounts ( large in relation to company) of contingencies; operating commitments, “off balance sheet finance”; and derivatives
Anticipated large capital expenditure commitments requiring external funding
Potentially large unfunded liabilities ( pensions, healthcare costs, environmental costs, lawsuits etc.)
Financial performance
Lower performance than peer group with weak operating and debt service ratios
Significant exceptional items
Limited “headroom” before breaching financial covenants
Low debt in relation to interest expense at prevailing interest rates
( “window dressing”)
Profitability but weak cash flow
Adverse trends in ratios such as receivables days which may indicate creative accounting
Substantial amounts of cash at the same time as company has large amounts of debt

5. Potential red flags – capital structure
Area
Indicators
Capital structure
Weak capitalization and debt service coverage
Bunching of debt maturities
Liquidity constraints
Significant use of Structured Finance and “off balance sheet finance”, and hybrid capital instruments
Complicated capital structure with “exotic” financing techniques
Material exposure to interest and currency fluctuations
Share buybacks in reaction to weak stock performance, particularly if debt financed